Has Inflation Targeting Represented a Policy Switch? Evidence from Markov Switching-Var and Time-Varying Parameters

Abstract

Whereas existing literature on inflation targeting has up to now focused on its impact on macroeconomic variables, this paper aims at investigating empirically whether the adoption of this framework has changed the preferences of the central banker. Using Markov-Switching VAR and Time Varying Parameters, we test the hypothesis that inflation targeting has constituted a switch towards a greater focus on inflation as conventional wisdom suggests. These two methods share the advantage of being nonlinear, of accounting for heteroskedasticity and of escaping the issue of choosing a date break. Our main results show that inflation targeting has not led to a stronger response to inflation and that the relative weight of inflation compared to output gap has decreased.